• 054 11/05/2016

    We are making baby steps towards profitability at ASimpleModel.com! This month revenue covered all fixed expenses excluding web design / development efforts and my time. A small victory, but it was exciting nonetheless. The most recent installment walks through these updates, and demonstrates how quickly you can update a business dashboard once you have one built. For those that are interested I have included an image of the business dashboard at the bottom of this post.

    For the uninitiated, ASM has a video series showcasing the business model behind this website. In this series you will learn how to organize real revenue and expense data, and transform it into useful information. The image below shows this first step (click to enlarge).

    Startup Business Dashboard

    Once we have all data organized longitudinally by revenue or expense category, the next step is to develop a business dashboard. To date we have developed a template with the following information:

    1. Daily Revenue

    2. Monthly Subscriber Count

    3. Monthly Revenue

    4. Monthly Expense Data

    5. Profit / (Loss)

    6. Investment to Date

    All of this information fits on one page, a portion of which is visible below (click on the image for an enlarged view).

    Startup Business Dashboard
 



  • 053 08/28/2016

    Note: Excel file available for download at the bottom of this post.

    To gauge interest in this topic, I thought I would post a few simple examples of a distribution waterfall. Distribution waterfalls define the economic relationship between the equity participants involved in an investment. In private equity transactions this generally focuses on the relationship between the general partner (“GP”) and limited partners (“LP”). If these terms are unfamiliar to you, think of the general partner as the private equity fund, and the limited partners as all of the investors participating in the fund. In this context, the purpose of a distribution waterfall is to prioritize the distribution of cash flows between the investors and private equity fund managers. 

    I believe the easiest way to grasp this concept is to focus on the acquisition and sale of one business. This limits the exercise to two cash flows, the capital invested to make the acquisition, and the transaction proceeds received at exit (when the business is sold). In this process, the limited partners would provide the capital to make the acquisition, and the general partner would identify the target company, work towards an acquisition, manage the investment over a three to seven year period, and finally identify a buyer. Upon a successful exit (sale of the business), the GP would earn a carried interest (share of the proceeds) for their efforts.

    In the Excel file attached you will find four simple examples in increasing order of complexity. The first tab titled "80_20," includes only two steps (see below). Real estate distribution waterfalls often follow a similar approach, but the split between the GP and LP is more favorable to the GP. You might see a 50/50 split in place of an 80/20 split, for example.

    First, 100% of all cash inflows to the LP until the cumulative distributions equal the original capital invested plus some preferred return. In the examples provided in this post, the preferred return is equivalent to 8% per annum. 

    Second, thereafter, cash flows in excess of distributions made in step 1 and step 2 (if any) are distributed 80% to the LP and 20% to the GP. This is often referred to as an "80/20 split."

    The second tab titled "20% & 80_20" includes three steps. Within the private equity community, some variation of this approach, including additional detail around fees and, in the case of a fund, whether or not this should be calculated for each deal or the fund as a whole, is not uncommon. 

    First, 100% of all cash inflows to the LP until the cumulative distributions equal the original capital invested plus some preferred return.  

    Second, a "20% catch-up" to the GP equivalent to 20% of the of the distributions realized in step 1 plus the distributions realized in this step. 

    Third, thereafter, cash flows in excess of distributions made in step 1 and step 2 (if any) are distributed 80% to the LP and 20% to the GP. 

    The third tab titled "20% After Pref & 80_20" adds one step to the sequence above so that the 20% catch up is limited to distributions made after the return of invested capital. Though simplified, this is perhaps the most frequently cited example for a private equity transaction. Hopefully the jump from tab two to tab three makes it a little easier to understand.

    First, 100% of all cash inflows to the LP until the cumulative distributions equal the original capital invested.

    Second, 100% of all cash inflows to the LP until the LP has received a preferred return on the capital invested in step 1.  

    Third, a "20% catch-up" to the GP equivalent to 20% of the distributions realized in step 2 plus the distributions realized in this step. 

    Fourth, thereafter, cash flows in excess of distributions made in step 1, 2 and 3 (if any) are distributed 80% to the LP and 20% to the GP. 

    The final tab gets a little more creative, and rewards the management team and sponsor according to IRR hurdles achieved. As the number of private equity groups and fundless sponsors has grown, I have seen a variety of new approaches, this being one of them. I also wanted to include it to demonstrate the degree to which there is flexibility in negotiating the terms of a distribution waterfall.  A screenshot of this tab has been provided below.

    CLICK HERE TO DOWNLOAD THE EXCEL FILE

    For an example of a real estate distribution waterfall click HERE.

    For an explanation of the math behind the 20% catch up click HERE.

    Click HERE to have posts like this one sent directly to your inbox.

    Private Equity
 Distribution Waterfall

     

     
 



  • 052 08/23/2016 What Is the Best Textbook on Investing?

    Investing is unusual in that the greatest enjoy writing about their profession. I would skip the textbooks and read the investor letters, memos and books that these individuals write.

    Start with Joel Greenblatt: Not only is he excellent at outperforming the market - he managed an annualized return of 50% over the course of a decade at Gotham Capital - he also has an unusual sense of humor. I like to think it's why the cover of one of his books is covered in $100 bills and that perhaps he named his fund, Gotham Capital, in homage to Batman.

    The Little Book That Still Beats the Market - this book introduces Joel Greenblatt’s “magic formula” for investing. Whether you want to take this approach or not, the book does an excellent job explaining what he believes are the most important metrics: earnings yield and return on capital. This is described in an incredibly simple and insightful way.

    I would actually follow with another of Greenblatt’s books: You Can Be a Stock Market Genius - ignore the cheesy title and book cover, this is a brilliant text. It does an incredible job explaining the advantage of the individual over Wall Street professionals, and it does so with simple language. Consider his comments on concentrated investing:

    Statistics say that owning just two stocks eliminates 46 percent of the nonmarket risk of owning just one stock. This type of risk is supposedly reduced by 72 percent with a four-stock portfolio, by 81 percent with eight stocks, 93 percent with 16 stocks, 96 percent with 32 stocks, and 99 percent with 500 stocks. Without quibbling over the accuracy of these particular statistics, two things should be remembered:

    1. After purchasing six or eight stocks in different industries, the benefit of adding even more stocks to your portfolio in an effort to decrease risk is small, and

    2. Overall market risk will not be eliminated merely by adding more stocks to your portfolio.

    After that I would move on to Howard Marks’ book The Most Important Thing Illuminated. The book is annotated by some of the greatest investors including Christopher Davis, Joel Greenblatt, Paul Johnson and Seth Klarman, which makes it truly unique. Marks also does an excellent job of explaining difficult concepts in simple terms, and uses a lot of anecdotal or historical references that make the text enjoyable.

    Also, read his memos: Memos from Howard Marks

    Next, I would pick up The Little Book of Valuation by Aswath Damodaran (professor and investor). This will permit diving a little deeper into the math (not that it’s complicated). In fact, Damodaran writes in his introduction:

    I believe that valuation, at its core, is simple, and anyone who is willing to spend time collecting and analyzing information can do it. I show you how in this book.

    And in the first chapter:

    “When valuing an asset, use the simplest model you can. If you can value an asset with three inputs, don’t use five. If you can value a company with three years of forecasts, forecasting 10 years of cash flows is asking for trouble. Less is more.”

    After that the book dives right in with time value of money, acct 101, multiples and specific examples. (Don’t let the title fool you, the book contains an incredible amount of information).

    Also, check out his blog: Musings on Markets

    Finally, I have to recommend Irrational Exuberance - it is one of my favorite books on markets. The intro describes it well “this book is really about the behavior of all speculative markets, about human vulnerability to error, and about the instabilities of the capitalist system.” Written by Robert Shiller, this text is a little more dense, but it is brilliant.

    The amazing thing about all of these texts is that they are pretty easy to read. If this subject genuinely interests you, it should not be difficult to work through these.

    Additional writers / resources worth following:

    Charlie Munger - Anything he writes is worth reading.

    Berkshire Hathaway Annual Reports - http://www.berkshirehathaway.com...

    Michael Mauboussin - Reflections on the Ten Attributes of Great Investors (recent example)

    John C Bogle - Founder and retired CEO of Vanguard - http://johncbogle.com/wordpress/...

    Barron’s often publishes great interviews that offer a lot of insight as well.

    And if you’re willing to commit to dense material:

    Security Analysis by Benjamin Graham and David Dodd or The Intelligent Investor by Benjamin Graham

    And Valuation

    Note: Originally answered on Quora.

 




 



Models are:
 
A) really boring
B) pretty sweet
C) super important
D) somewhat easy
E) kind of hard
F) fun
G) all of the above

 

 


*Answers a, b, c, d, e, f and g are all correct.